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Tuesday, July 7, 1998
3Dfx Interactive Inc.
<% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: TDFX)") else Response.Write("(Nasdaq: TDFX)") end if %>
Phone: 408-935-4400
Website: http://www.3dfx.com
Price (7/6/98): $16 15/16
HOW DID IT FIND TROUBLE?
Score one for the baddies. After three consecutive quarters of at least 100% earnings growth, 3Dfx is slowing down. Despite the early success of the company's latest generation of video chipsets for personal computers, the company has acknowledged that revenues over the next two quarters will grow in the 15-20% range with earnings tracking below that.
While this might have been just a cautionary setback in most cases -- nothing more than a forgivable cyclical flux or maybe a growth company pondering maturity -- it was different this time. Intel <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: INTC)") else Response.Write("(Nasdaq: INTC)") end if %> was inside. Intel was way inside.
The very whiff of Intel's scent sent investors scrambling. 3Dfx had done nothing but blow out earning expectations and cement its presence in the past. However, with Intel entering the low-end segment with the i740, visions of another semiconductor stock massacre crystallized. Just as DRAM manufacturers had gone from boom to bust, Wall Street figured that Intel might ignite another commodity niche.
Right or wrong, that was the perception -- and perception moves stocks. Shares of 3Dfx, after soaring to an all-time high in April, faded to black.
BUSINESS DESCRIPTION
What exactly is a graphics accelerator card? It works in unison with a computer's existing video card to provide enhanced graphics and speed. With applications in everything from engineering to architectural design, the improved visuals that accelerator cards provide have especially found eager recipients in the computers of die-hard gamers.
California-based 3Dfx does not make the cards. The company simply designs the chipsets that are produced in Taiwan and then sold to companies like Diamond Multimedia <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: DIMD)") else Response.Write("(Nasdaq: DIMD)") end if %>, its largest customer.
3Dfx came public in June of 1997 at $11 a share and just released the more powerful Voodoo2. 3Dfx's newest chipset is the 2D/3D Banshee. Earlier this year, 3Dfx became an addition to the Fool Portfolio.
FINANCIAL FACTS
Income Statement
12-month sales: $88.8 million
12-month income: $6.9 million
12-month EPS: $0.46
Profit Margin: 7.8%
Market Cap: $259.1 million
Balance Sheet
Cash and Investments: $93.2 million
Current Assets: $148.2 million
Current Liabilities: $49.0 million
Long-term Debt: $0.4 million
Ratios
Price-to-earnings: 36.8
Price-to-sales: 2.9
HOW COULD YOU HAVE SEEN IT COMING?
After a stunning March quarter, where earnings of $0.50 a share blew away estimates of $0.24 a share, the euphoria was short-lived. The stock had just peaked at $35 1/4 and the conference call was not necessarily as cheery as that of a company that had not only doubled sequential earnings, but doubled earnings estimates as well.
Beyond the earnings growth slowdown, the impressive 51% gross margins for the quarter were expected to come down. As 3Dfx looked to grow beyond its after market sales stronghold, it was hoping to strengthen its position with the Original Equipment Manufacturers (OEM). Selling pre-installed products through the computer makers themselves may have practical benefits, but it is a low-margin business. While the upside may have been that 3Dfx could then discard the practically obsolete Voodoo chipset cards quietly for $20-30 a pop, that in itself would bring on lower average selling prices.
This was still a solid growth company, but certainly not the high-octane bulldozer some shareholders expected it to be. While the company had made major inroads in establishing brand equity, an amazing feat relative to the nameless competitors like ATI and Matrox, Intel's introduction of the i740 threatened the lead that 3Dfx had created with its superior technology and widespread market acceptance.
Not that anyone would think Intel's product would be superior. However, by commoditizing the low-end, was the high-end safe? If not, then was 3Dfx stock safe?
WHERE TO FROM HERE?
The dramatic retail price slashing on computers has been great for consumers, but not so for the hardware makers. This has put on the pressure to cut costs, and that means the further commodity-driven treatment of peripherals. If 3Dfx is hoping to make a dent in the high-end market, it is there, but sorely limited.
Yet, 3Dfx is different. Two-thirds of the hottest software games that advertise 3D gameplay carry 3Dfx logos. The branding efforts have been an attempt to try to make the company a household word beyond die-hard gamers, as well as to set the company apart as having more complete software compatibility than everybody else.
The problem, however, is that software companies, which were expected to reap the fruits that came in the harvest of cheaper yet more powerful computers, have not been stellar performers. Myst-maker Broderbund <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: BROD)") else Response.Write("(Nasdaq: BROD)") end if %> recently had a fire sale as it submitted to a buyout offer at half of what the shares were trading for a year ago. Some of the blame could be placed at the recent success of the Sony PlayStation and Nintendo 64 home game consoles. While Voodoo2 is ten times faster than Nintendo 64, the improvement seems to be lost on cost-conscious gamers.
But 3Dfx appears to be in better shape than most think. For now, the company is in an envious position as the market leader with a new product set to roll out later this quarter. By completing a secondary offering earlier this year when the stock was climbing, the company has also bulked up its cash-rich balance sheet. But the most compelling reason to consider 3Dfx today is that the price-to-earnings valuation is ludicrously cheap even for a stagnant company. With estimates calling for the company to earn $1.85 a share this year and grow modestly to $1.98 a share next year, and this coming from mostly neutral analysts, the single-digit P/E ratio seems to scream bargain. Screaming, like a Banshee.
-Rick Aristotle Munarriz
([email protected])
Check out the Daily Trouble Message Board!
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